Suppose that economic base of the city is experiencing a change in technology. S

Question

Suppose that economic base of the city is experiencing a change in technology. Suppose that a dominant local industry, which produces something needed by all other local industries, used to display increasing returns to scale. The new technology reduces the average cost of production (given the current level of production) and displays constant returns to scale.

a) Would this change in technology affect the equilibrium size of the city?

b) Would the profit earned by local companies in other industries in equilibrium increase, decrease or stay the same because of the change in technology in the dominant industry?

Explanation / Answer

a) Equilibrium size will increase with new technology as it reduces average cost of production. Reduction in cost of production will increase the supply which in turn will increase the equilibrium quantity. Thus will increase the equilibrium size of the city.

b) Profit earned by local companies in other industries will also increase as it will recieve higher supply at lower price. Thus their profit in equilibrium will increase.

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